In today’s society, even if your daily routine does not consist of dealing with routine Real Estate transaction, most people have heard of a 1031 exchange. For some that have heard of 1031 exchange or maybe those that are not sure about its exact guidelines, here is a breakdown:
- 1031 exchange is a swap, exchange or trade of one business or investment for another
- Although most exchanges are taxable, a 1031 exchange is tax exempt or have limited tax restrictions
- There are no limit as to how many times you can do a 1031 exchange
- The provision is only for business investment and property (primary place of residence are excluded, with some loopholes regarding vacation homes which will be explained later)
- Most exchanges must be similar or “like -kind” but it’s rules are also very liberal; for example, you can exchange an apartment for bare land or as a typical 1031, which is exchange of one business investment for another
- If you can’t find a property that suits your liking, you can do a “delayed” exchange. Basically, once you sell your property, a third party middleman holds the cash for you until you find another investment property to buy. This process is also called a Starker Exchange. Within 45 days of the sale of your property, you must find another replacement property (up to 3 potential replacement property are allowed according to the IRS as long as you close on one of them) and indicate in writing to the intermediary of your intention to purchase. One should also note that you have 180 days from the time you sell your property to close on your new property. If you have cash left over known as “boot” after the purchase of your replacement property, that earning is subject to be taxed because it is regarded as capital gain.
- 1031 exchange can be used for a vacation home that you no longer use as well and have converted it into a rental investment property. The key is to have a property rented for a good amount of time, preferably a year, before you decide to do the 1031 exchange.